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Q: To increase a given present value the discount rate should be adjusted?
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What are the similarities and differences between the risk-adjusted discount rate and the certainty equivalent methods for incorporating risk into the capital-budgeting?

The primary difference between the certainty equivalent approach and the risk-adjusted discount rate approach is where the adjustment for risk is incorporated into the calculations. The certainty equivalent approach penalizes or adjusts downwards the value of the expected annual free cash flows, while the risk-adjusted discount rate leaves the cash flows at their expected value and adjusts the required rate of return, k, upwards to compensate for added risk. In either case the net present value of the project is being adjusted downwards to compensate for additional risk. An additional difference between these methods is that the risk-adjusted discount rate assumes that risk increases over time and that cash flows occurring later in the future should be more severely penalized. The certainty equivalent method, on the other hand, allows each cash flow to be treated individually.


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Discount rate = inflation expectation + risk premium for the investment, so when inflation goes up, your discount rate should go up


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No, it should decrease, assuming the interest rate is the same.


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